NOTE 1: BASIS OF PRESENTATION

 

The consolidated financial statements include the accounts of Simmons First National Corporation (the “Company”) and its subsidiaries.  Significant intercompany accounts and transactions have been eliminated in consolidation.

 

In the opinion of management, all adjustments necessary for a fair presentation of the results of interim periods have been made.  Certain gains and fees were reclassified within non-interest income categories in the 2016 financial statements to conform to the 2017 presentation. These reclassifications were not material to the consolidated financial statements. The consolidated balance sheet of the Company as of December 31, 2016, has been derived from the audited consolidated balance sheet of the Company as of that date.  The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

 

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K Annual Report for 2016 filed with the U.S. Securities and Exchange Commission (the “SEC”).

 

Recently Issued Accounting Pronouncements

 

ASU 2017-09 – Stock Compensation: Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation - Stock Compensation, to a change to the terms or conditions of a share-based payment award. An entity may change the terms or conditions of a share-based payment award for many different reasons, and the nature and effect of the change can vary significantly. ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact this standard will have on the Company’s results of operations, financial position or disclosures, but it is not expected to have a material impact.

 

ASU 2017-08 – Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”). ASU 2017-08 amends the amortization period for certain purchased callable debt securities held at a premium. Specifically, the amendments shorten the amortization period by requiring that the premium be amortized to the earliest call date. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We elected to adopt the provisions of ASU 2017-08 during the quarter ended March 31, 2017 in advance of the required application date. The adoption of this standard did not have a material effect on the Company’s results of operations, financial position or disclosures.

 

ASU 2017-04 – Goodwill and Other: Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compare the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted for interim or annual impairment tests beginning in 2017. ASU 2017-04 is not expected to have a material effect on the Company’s results of operations, financial position or disclosures.

 

ASU 2016-15 – Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 is designed to address the diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The standard also provides guidance on when an entity should separate or aggregate cash flows based on the predominance principle. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Since ASU 2016-15 applies to the classification of cash flows, no impact is anticipated on the Company’s financial position or results of operations; however, the Company is currently evaluating the impact this standard will have on its financial statement disclosures, but it is not expected to have a material impact.

 

 

ASU 2016-13 – Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires earlier measurement of credit losses, expands the range of information considered in determining expected credit losses and enhances disclosures. The main objective of ASU 2016-13 is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP (“Accounting Principles Generally Accepted in the United States of America”) with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We have formed a cross functional team that is assessing our data and system needs and is evaluating the impact of adopting the new guidance. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact on the Company’s results of operations, financial position or disclosures.

 

ASU 2016-09 – Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 became effective for annual and interim periods beginning after December 15, 2016. The prospective adoption of this standard has not had a material effect on the Company’s results of operations, financial position or disclosures. The impact of the requirement to report those income tax effects in earnings reduced reported federal and state income tax expense by $0.3 million and $1.5 million, respectively, for the three and six months ended June 30, 2017.

 

ASU 2016-02 – Leases (“ASU 2016-02”). ASU 2016-02 establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. The new guidance results in a more consistent representation of the rights and obligations arising from leases by requiring lessees to recognize the lease asset and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Based on leases outstanding as of June 30, 2017, we do not expect the new standard to have a material impact on our results of operations, but anticipate increases in our assets and liabilities. Decisions to repurchase, modify or renew leases prior to the implementation date will impact the level of materiality.

 

ASU 2016-01 – Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”).  ASU 2016-01 makes changes primarily affecting the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. ASU 2016-01 is effective for fiscal periods beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact this standard will have on the Company’s results of operations, financial position or disclosures, but it is not expected to have a material impact.

 

ASU 2015-16 – Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments (“ASU 2015-16”).  ASU 2015-16 requires entities to recognize measurement period adjustments during the reporting period in which the adjustments are determined.  The income effects, if any, of a measurement period adjustment are cumulative and are to be reported in the period in which the adjustment to a provisional amount is determined.  Also, ASU 2015-16 requires presentation on the face of the income statement or in the notes, the effect of the measurement period adjustment as if the adjustment had been recognized at acquisition date. Under previous guidance, adjustments to provisional amounts identified during the measurement period are to be recognized retrospectively. ASU 2015-16 became effective for annual and interim periods beginning after December 15, 2015 and should be applied prospectively to measurement period adjustments that occur after the effective date. The adoption of this standard has not had a material effect on the Company’s results of operations, financial position or disclosures.

 

 

ASU 2015-14 – Revenue from Contracts with Customers: Deferral of the Effective Date (“ASU 2015-14”). ASU 2015-14 is an update to the effective date in ASU 2014-09 – Revenue from Contracts with Customers (“ASU 2014-09”). ASU2014-09 provides guidance that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2015-14 is effective prospectively, for annual and interim periods, beginning after December 15, 2017. The adoption of this standard is not expected to have a material effect on the Company’s results of operations, financial position or disclosures. The guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, which comprises a significant portion of our revenue stream. We believe that for most revenue streams within the scope of ASU 2015-14, the amendments will not change the timing of when the revenue is recognized. We will continue to evaluate the impact focusing on noninterest income sources within the scope of ASU 2015-14; however, we do not expect adoption to have a material impact on the Company’s results of operations, financial position or disclosures.

 

There have been no other significant changes to the Company’s accounting policies from the 2016 Form 10-K.  Presently, the Company is not aware of any other changes to the Accounting Standards Codification that will have a material impact on the Company’s present or future financial position or results of operations.

 

Acquisition Accounting, Loans Acquired

 

The Company accounts for its acquisitions under ASC Topic 805, Business Combinations , which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the loans acquired is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.

 

The Company evaluates loans acquired, other than purchased impaired loans, in accordance with the provisions of ASC Topic 310-20, Nonrefundable Fees and Other Costs . The fair value discount on these loans is accreted into interest income over the weighted average life of the loans using a constant yield method. The Company evaluates purchased impaired loans in accordance with the provisions of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality . Purchased loans are considered impaired if there is evidence of credit deterioration since origination and if it is probable that not all contractually required payments will be collected.

 

For impaired loans accounted for under ASC Topic 310-30, the Company continues to estimate cash flows expected to be collected on these loans. The Company evaluates at each balance sheet date whether the present value of the loans determined using the effective interest rates has decreased significantly and if so, recognizes a provision for loan loss in the consolidated statement of income. For any significant increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the remaining life of the loan.

 

For further discussion of our acquisition and loan accounting, see Note 2, Acquisitions, and Note 5, Loans Acquired.

 

 

Earnings Per Common Share (“EPS”)

 

Basic EPS is computed by dividing reported net income available to common shareholders by weighted average number of common shares outstanding during each period.  Diluted EPS is computed by dividing reported net income available to common shareholders by the weighted average common shares and all potential dilutive common shares outstanding during the period.

 

Following is the computation of earnings per common share for the three and six months ended June 30, 2017 and 2016:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(In thousands, except per share data)		2017				2016				2017				2016
Net income available to common shareholders		$	23,065			$	22,909			$	45,185			$	46,390
Average common shares outstanding			31,817				30,353				31,585				30,340
Average potential dilutive common shares			209				99				209				99
Average diluted common shares			32,026				30,452				31,794				30,439
Basic earnings per share		$	0.72			$	0.75			$	1.43			$	1.53
Diluted earnings per share (1)		$	0.72			$	0.75			$	1.42			$	1.52

____________________________

(1)

Stock options to purchase 258,255 and 65,005 shares for the three and six months ended June 30, 2016 were not included in the diluted EPS calculation because the exercise price of those options exceeded the average market price. There were no stock options excluded from the earnings per share calculation due to the related exercise price exceeding the average market price for the three and six months ended June 30, 2017.

NOTE 2: ACQUISITIONS

 

Hardeman County Investment Company, Inc.

 

On May 15, 2017, the Company completed the acquisition of Hardeman County Investment Company, Inc. (“Hardeman”), headquartered in Jackson, Tennessee, including its wholly-owned bank subsidiary, First South Bank. The Company issued 799,970 shares of its common stock valued at approximately $42.6 million as of May 15, 2017, plus $30.0 million in cash in exchange for all outstanding shares of Hardeman common stock.

 

Prior to the acquisition, Hardeman conducted banking business from 10 branches located in western Tennessee. Including the effects of the acquisition method accounting adjustments, the Company acquired approximately $462.9 million in assets, including approximately $251.6 million in loans (inclusive of loan discounts) and approximately $389.0 million in deposits. The Company expects to complete the systems conversion and merge First South Bank into Simmons Bank in September 2017. As part of the systems conversion, 5 existing Simmons and First South Bank branches will be consolidated.

 

Goodwill of $29.4 million was recorded as a result of the transaction. The merger strengthened the Company’s position in the western Tennessee market and the Company will be able to achieve cost savings by integrating the two companies and combining accounting, data processing, and other administrative functions all of which gave rise to the goodwill recorded. The goodwill will not be deductible for tax purposes.

 

 

A summary, at fair value, of the assets acquired and liabilities assumed in the Hardeman transaction, as of the acquisition date, is as follows:

 

(In thousands)		Acquired from Hardeman				Fair Value Adjustments				Fair Value
Assets Acquired
Cash and due from banks		$	8,001			$	--			$	8,001
Interest bearing balances due from banks - time			1,984				--				1,984
Investment securities			170,654				(316	)			170,338
Loans acquired			257,641				(5,992	)			251,649
Allowance for loan losses			(2,382	)			2,382				--
Foreclosed assets			1,083				(452	)			631
Premises and equipment			9,905				1,258				11,163
Bank owned life insurance			7,819				--				7,819
Goodwill			11,485				(11,485	)			--
Core deposit intangible			--				7,840				7,840
Other intangibles			--				830				830
Other assets			2,639				(1	)			2,638
Total assets acquired		$	468,829			$	(5,936	)		$	462,893
Liabilities Assumed
Deposits:
Non-interest bearing transaction accounts		$	76,555			$	--			$	76,555
Interest bearing transaction accounts and savings deposits			214,872				--				214,872
Time deposits			97,917				(368	)			97,549
Total deposits			389,344				(368	)			388,976
Securities sold under agreement to repurchase			17,163				--				17,163
Other borrowings			3,000				--				3,000
Subordinated debentures			6,702				--				6,702
Accrued interest and other liabilities			1,891				1,924				3,815
Total liabilities assumed			418,100				1,556				419,656
Equity			50,729				(50,729	)			--
Total equity assumed			50,729				(50,729	)			--
Total liabilities and equity assumed		$	468,829			$	(49,173	)		$	419,656
Net assets acquired											43,237
Purchase price											72,639
Goodwill										$	29,402

 

The purchase price allocation and certain fair value measurements remain preliminary due to the timing of the acquisition. Management will continue to review the estimated fair values and evaluate the assumed tax positions. The Company expects to finalize its analysis of the acquired assets and assumed liabilities in this transaction over the next few months, within one year of the acquisition. Therefore, adjustments to the estimated amounts and carrying values may occur.  

 

The Company’s operating results for 2017 include the operating results of the acquired assets and assumed liabilities of Hardeman subsequent to the acquisition date.

 

Citizens National Bank

 

On September 9, 2016, the Company completed the acquisition of Citizens National Bank (“Citizens”), headquartered in Athens, Tennessee. The Company issued 835,741 shares of its common stock valued at approximately $41.3 million as of September 9, 2016, plus $35.0 million in cash in exchange for all outstanding shares of Citizens common stock.

 

Prior to the acquisition, Citizens conducted banking business from 9 branches located in east Tennessee. Including the effects of the acquisition method accounting adjustments, the Company acquired approximately $585.5 million in assets, including approximately $340.9 million in loans (inclusive of loan discounts) and approximately $509.9 million in deposits. The Company completed the systems conversion and merged Citizens into Simmons Bank on October 21, 2016.

 

Goodwill of $23.0 million was recorded as a result of the transaction. The merger strengthened the Company’s position in the east Tennessee market and the Company is able to achieve cost savings by integrating the two companies and combining accounting, data processing, and other administrative functions all of which gave rise to the goodwill recorded. The goodwill will be deductible for tax purposes.

 

 

A summary, at fair value, of the assets acquired and liabilities assumed in the Citizens transaction, as of the acquisition date, is as follows:

 

(In thousands)		Acquired from Citizens				Fair Value Adjustments				Fair Value
Assets Acquired
Cash and due from banks		$	131,467			$	--			$	131,467
Federal funds sold			10,000				--				10,000
Investment securities			61,987				1				61,988
Loans acquired			350,361				(9,511	)			340,850
Allowance for loan losses			(4,313	)			4,313				--
Foreclosed assets			4,960				(1,518	)			3,442
Premises and equipment			6,746				1,339				8,085
Bank owned life insurance			6,632				--				6,632
Core deposit intangible			--				5,075				5,075
Other intangibles			--				591				591
Other assets			17,364				6				17,370
Total assets acquired		$	585,204			$	296			$	585,500
Liabilities Assumed
Deposits:
Non-interest bearing transaction accounts		$	109,281			$	--			$	109,281
Interest bearing transaction accounts and savings deposits			204,912				--				204,912
Time deposits			195,664				--				195,664
Total deposits			509,857				--				509,857
Securities sold under agreement to repurchase			13,233				--				13,233
FHLB borrowings			4,000				47				4,047
Accrued interest and other liabilities			3,558				1,530				5,088
Total liabilities assumed			530,648				1,577				532,225
Equity			54,556				(54,556	)			--
Total equity assumed			54,556				(54,556	)			--
Total liabilities and equity assumed		$	585,204			$	(52,979	)		$	532,225
Net assets acquired											53,275
Purchase price											76,300
Goodwill										$	23,025

 

The purchase price allocation and certain fair value measurements remain preliminary due to the timing of the acquisition. Management will continue to review the estimated fair values and to evaluate the assumed tax positions. The Company expects to finalize its analysis of the acquired assets and assumed liabilities in this transaction over the next few months, within one year of the acquisition. Therefore, adjustments to the estimated amounts and carrying values may occur.  

 

The Company’s operating results for 2017 and 2016 include the operating results of the acquired assets and assumed liabilities of Citizens subsequent to the acquisition date.  

 

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented in the acquisitions above.

 

 

Cash and due from banks, time deposits due from banks and federal funds sold – The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of these assets.

 

Investment securities – Investment securities were acquired with an adjustment to fair value based upon quoted market prices if material. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Loans acquired – Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates.  The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns.  The discount rate does not include a factor for credit losses as that has been included in the estimated cash flows.  Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques.

 

Foreclosed assets held for sale – These assets are presented at the estimated present values that management expects to receive when the properties are sold, net of related costs of disposal.

 

Premises and equipment – Bank premises and equipment were acquired with an adjustment to fair value, which represents the difference between the Company’s current analysis of property and equipment values completed in connection with the acquisition and book value acquired.

 

Bank owned life insurance – Bank owned life insurance is carried at its current cash surrender value, which is the most reasonable estimate of fair value.

 

Goodwill – The consideration paid as a result of the acquisition exceeded the fair value of the assets acquired, resulting in an intangible asset, goodwill. Goodwill established prior to the acquisitions, if applicable, was written off.

 

Core deposit intangible – This intangible asset represents the value of the relationships that the acquired banks had with their deposit customers.  The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base and the net maintenance cost attributable to customer deposits. Core deposit intangible established prior to the acquisitions, if applicable, was written off.

 

Other intangibles – This intangible assets represent the value of the relationships that Citizens had with their trust customers and Hardeman had with their insurance customers.  The fair value of these intangible assets was estimated based on a combination of discounted cash flow methodology and a market valuation approach. Other intangibles established prior to the acquisitions, if applicable, was written off.

 

Other assets – The fair value adjustment results from certain assets whose value was estimated to be less than book value, such as certain prepaid assets, receivables and other miscellaneous assets. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Deposits – The fair values used for the demand and savings deposits that comprise the transaction accounts acquired, by definition equal the amount payable on demand at the acquisition date.  The Company performed a fair value analysis of the estimated weighted average interest rate of the certificates of deposits compared to the current market rates and recorded a fair value adjustment for the difference when material.

 

Securities sold under agreement to repurchase – The carrying amount of securities sold under agreement to repurchase is a reasonable estimate of fair value based on the short-term nature of these liabilities.

 

FHLB and other borrowings – The fair value of Federal Home Loan Bank and other borrowings is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

 

Subordinated debentures – The fair value of subordinated debentures is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities. Due to the floating rate nature of the debenture, the fair value approximates book value as of the date acquired.

 

Accrued interest and other liabilities – The adjustment establishes a liability for unfunded commitments equal to the fair value of that liability at the date of acquisition.

 

 

Southwest Bancorp, Inc. (Pending Acquisition)

 

On December 14, 2016, the Company announced that it has entered into a definitive agreement and plan of merger (“SBI Agreement”) with Southwest Bancorp, Inc. (“SBI”), headquartered in Stillwater, Oklahoma, including its wholly-owned bank subsidiary, Bank SNB. According to the terms of the SBI Agreement, the Company will acquire all of the outstanding common stock of SBI in a transaction valued at approximately $564.4 million (based on the Company’s common stock closing price as of December 13, 2016), subject to potential adjustments. The transaction is expected to be accretive to the Company’s diluted core earnings per common share in the first full year of operation.

 

SBI conducts banking business from 31 branches located in Oklahoma, Colorado, Kansas and Texas. As of December 31, 2016, SBI had approximately $2.5 billion in assets, $1.9 billion in loans and $1.9 billion in deposits. Completion of the transaction is expected as early as October 2017 or as late as January 2018 and is subject to certain closing conditions, including approval by the shareholders of both SBI and the Company and customary regulatory approvals. Upon closing, SBI will merge into the Company.

 

First Texas BHC, Inc. (Pending Acquisition)

 

On January 23, 2017, the Company announced that it has entered into a definitive agreement and plan of merger (“First Texas Agreement”) with First Texas BHC, Inc. (“First Texas”), headquartered in Fort Worth, Texas, including its wholly-owned bank subsidiary, Southwest Bank. According to the terms of the First Texas Agreement, the Company will acquire all of the outstanding common stock of First Texas in a transaction valued at approximately $462 million (based on the Company’s common stock closing price as of January 20, 2017), subject to potential adjustments. The transaction is expected to be accretive to the Company’s diluted core earnings per common share in the first full year of operation.

 

First Texas conducts banking business from 16 branches located in the Dallas/Fort Worth Metroplex. As of December 31, 2016, First Texas had approximately $2.1 billion in assets, $1.8 billion in loans and $1.7 billion in deposits. Completion of the transaction is expected as early as October 2017 or as late as January 2018 and is subject to certain closing conditions, including approval by the shareholders of both First Texas and the Company and customary regulatory approvals. Upon closing, First Texas will merge into the Company.

15

 

NOTE 3: INVESTMENT SECURITIES

 

The amortized cost and fair value of investment securities that are classified as held-to-maturity (“HTM”) and available-for-sale (“AFS”) are as follows:

 

		June 30, 2017																December 31, 2016
(In thousands)		Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Estimated Fair Value				Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Estimated Fair Value
Held-to-Maturity
U.S. Government agencies		$	67,912			$	52			$	(178	)		$	67,786			$	76,875			$	107			$	(182	)		$	76,800
Mortgage-backed securities			17,882				66				(198	)			17,750				19,773				63				(249	)			19,587
State and political subdivisions			331,249				6,623				(105	)			337,767				362,532				4,967				(842	)			366,657
Other securities			1,960				--				--				1,960				2,916				--				--				2,916
Total HTM		$	419,003			$	6,741			$	(481	)		$	425,263			$	462,096			$	5,137			$	(1,273	)		$	465,960
Available-for-Sale
U.S. Treasury		$	19,996			$	1			$	--			$	19,997			$	300			$	--			$	--			$	300
U.S. Government agencies			149,296				213				(1,890	)			147,619				140,005				67				(2,301	)			137,771
Mortgage-backed securities			892,080				95				(13,970	)			878,205				885,783				178				(17,637	)			868,324
State and political subdivisions			86,915				133				(3,376	)			83,672				108,374				38				(5,469	)			102,943
Other securities			59,990				1,117				--				61,107				47,022				996				(2	)			48,016
Total AFS		$	1,208,277			$	1,559			$	(19,236	)		$	1,190,600			$	1,181,484			$	1,279			$	(25,409	)		$	1,157,354

 

Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as other available-for-sale securities in the table above.

 

Certain investment securities are valued at less than their historical cost.  Total fair value of these investments at June 30, 2017, was $1.1 billion, which is approximately 69.6% of the Company’s combined available-for-sale and held-to-maturity investment portfolios.

 

 

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2017:

 

		Less Than 12 Months								12 Months or More								Total
(In thousands)		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
Held-to-Maturity
U.S. Government agencies		$	14,938			$	(62	)		$	37,883			$	(116	)		$	52,821			$	(178	)
Mortgage-backed securities			10,036				(151	)			1,291				(47	)			11,327				(198	)
State and political subdivisions			18,939				(104	)			225				(1	)			19,164				(105	)
Total HTM		$	43,913			$	(317	)		$	39,399			$	(164	)		$	83,312			$	(481	)
Available-for-Sale
U.S. Government agencies		$	111,504			$	(1,761	)		$	16,868			$	(129	)		$	128,372			$	(1,890	)
Mortgage-backed securities			785,746				(12,903	)			45,673				(1,067	)			831,419				(13,970	)
State and political subdivisions			57,309				(2,137	)			20,158				(1,239	)			77,467				(3,376	)
Other securities			100				--				--				--				100				--
Total AFS		$	954,659			$	(16,801	)		$	82,699			$	(2,435	)		$	1,037,358			$	(19,236	)

 

These declines primarily resulted from the rate for these investments yielding less than current market rates.  Based on evaluation of available evidence, management believes the declines in fair value for these securities are temporary. Management does not have the intent to sell these securities and management believes it is more likely than not the Company will not have to sell these securities before recovery of their amortized cost basis less any current period credit losses.

 

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. 

 

Management has the ability and intent to hold the securities classified as held to maturity until they mature, at which time the Company expects to receive full value for the securities.  Furthermore, as of June 30, 2017, management also had the ability and intent to hold the securities classified as available-for-sale for a period of time sufficient for a recovery of cost.  The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  Management does not believe any of the securities are impaired due to reasons of credit quality.  Accordingly, as of June 30, 2017, management believes the impairments detailed in the table above are temporary.  Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

Income earned on securities for the three and six months ended June 30, 2017 and 2016, is as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(In thousands)		2017				2016				2017				2016
Taxable:
Held-to-maturity		$	636			$	1,446			$	1,297			$	2,323
Available-for-sale			6,238				4,492				12,054				8,926
Non-taxable:
Held-to-maturity			2,217				2,399				4,500				5,545
Available-for-sale			899				162				1,590				211
Total		$	9,990			$	8,499			$	19,441			$	17,005

 

 

 

The amortized cost and estimated fair value by maturity of securities are shown in the following table.  Securities are classified according to their contractual maturities without consideration of principal amortization, potential prepayments or call options.  Accordingly, actual maturities may differ from contractual maturities.

 

		Held-to-Maturity								Available-for-Sale
(In thousands)		Amortized Cost				Fair Value				Amortized Cost				Fair Value
One year or less		$	50,648			$	50,636			$	21,212			$	21,213
After one through five years			108,555				109,055				100,683				99,792
After five through ten years			100,222				101,798				8,941				8,712
After ten years			141,696				146,024				126,471				122,671
Securities not due on a single maturity date			17,882				17,750				892,080				878,205
Other securities (no maturity)			--				--				58,890				60,007
Total		$	419,003			$	425,263			$	1,208,277			$	1,190,600

 

The carrying value, which approximates the fair value, of securities pledged as collateral, to secure public deposits and for other purposes, amounted to $1.0 billion at June 30, 2017 and $915.2 million at December 31, 2016.

 

There were $2.2 million of gross realized gains and $5,000 of gross realized losses from the sale of available for sale securities during the three months ended June 30, 2017, and there were $2.3 million of realized gains and $5,000 of realized losses from the sale of available for sale securities during the six months ended June 30, 2017. There were $3.8 million of gross realized gains and no realized losses for the three months ended June 30, 2016, and there were $4.1 million of gross realized gains and no realized losses from the sale of available for sale securities during the six months ended June 30, 2016.

 

The state and political subdivision debt obligations are predominately non-rated bonds representing small issuances, primarily in Arkansas, Missouri, Tennessee and Texas issues, which are evaluated on an ongoing basis.

18

 

NOTE 4: LOANS AND ALLOWANCE FOR LOAN LOSSES

 

At June 30, 2017, the Company’s loan portfolio was $6.225 billion, compared to $5.633 billion at December 31, 2016.  The various categories of loans are summarized as follows:

 

(In thousands)		June 30, 2017				December 31, 2016
Consumer:
Credit cards		$	176,953			$	184,591
Other consumer			366,136				303,972
Total consumer			543,089				488,563
Real Estate:
Construction			457,896				336,759
Single family residential			1,014,412				904,245
Other commercial			2,089,707				1,787,075
Total real estate			3,562,015				3,028,079
Commercial:
Commercial			678,932				639,525
Agricultural			191,345				150,378
Total commercial			870,277				789,903
Other			25,191				20,662
Loans			5,000,572				4,327,207
Loans acquired, net of discount and allowance (1)			1,224,739				1,305,683
Total loans		$	6,225,311			$	5,632,890

____________________________                  

(1)

See Note 5, Loans Acquired, for segregation of loans acquired by loan class.

 

Loan Origination/Risk Management – The Company seeks to manage its credit risk by diversifying its loan portfolio, determining that borrowers have adequate sources of cash flow for loan repayment without liquidation of collateral; obtaining and monitoring collateral; providing an adequate allowance for loans losses by regularly reviewing loans through the internal loan review process.  The loan portfolio is diversified by borrower, purpose and industry.  The Company seeks to use diversification within the loan portfolio to reduce its credit risk, thereby minimizing the adverse impact on the portfolio, if weaknesses develop in either the economy or a particular segment of borrowers.  Collateral requirements are based on credit assessments of borrowers and may be used to recover the debt in case of default.  Furthermore, a factor that influenced the Company’s judgment regarding the allowance for loan losses consists of a five-year historical loss average segregated by each primary loan sector.  On an annual basis, historical loss rates are calculated for each sector.

 

Consumer – The consumer loan portfolio consists of credit card loans and other consumer loans.  Credit card loans are diversified by geographic region to reduce credit risk and minimize any adverse impact on the portfolio. Although they are regularly reviewed to facilitate the identification and monitoring of creditworthiness, credit card loans are unsecured loans, making them more susceptible to be impacted by economic downturns resulting in increasing unemployment.  Other consumer loans include direct and indirect installment loans and overdrafts.  Loans in this portfolio segment are sensitive to unemployment and other key consumer economic measures.

 

Real estate – The real estate loan portfolio consists of construction loans, single family residential loans and commercial loans.  Construction and development loans (“C&D”) and commercial real estate loans (“CRE”) can be particularly sensitive to valuation of real estate.  Commercial real estate cycles are inevitable.  The long planning and production process for new properties and rapid shifts in business conditions and employment create an inherent tension between supply and demand for commercial properties.  While general economic trends often move individual markets in the same direction over time, the timing and magnitude of changes are determined by other forces unique to each market.  CRE cycles tend to be local in nature and longer than other credit cycles.  Factors influencing the CRE market are traditionally different from those affecting residential real estate markets; thereby making predictions for one market based on the other difficult.  Additionally, submarkets within commercial real estate – such as office, industrial, apartment, retail and hotel – also experience different cycles, providing an opportunity to lower the overall risk through diversification across types of CRE loans.  Management realizes that local demand and supply conditions will also mean that different geographic areas will experience cycles of different amplitude and length.  The Company monitors these loans closely.

 

 

Commercial – The commercial loan portfolio includes commercial and agricultural loans, representing loans to commercial customers and farmers for use in normal business or farming operations to finance working capital needs, equipment purchase or other expansion projects.  Collection risk in this portfolio is driven by the creditworthiness of the underlying borrowers, particularly cash flow from customers’ business or farming operations.  The Company continues its efforts to keep loan terms short, reducing the negative impact of upward movement in interest rates.  Term loans are generally set up with one or three year balloons, and the Company has recently instituted a pricing mechanism for commercial loans.  It is standard practice to require personal guaranties on commercial loans for closely-held or limited liability entities.

 

Nonaccrual and Past Due Loans – Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions.  Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due.  When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Nonaccrual loans, excluding loans acquired, segregated by class of loans, are as follows:

 

(In thousands)		June 30, 2017				December 31, 2016
Consumer:
Credit cards		$	293			$	373
Other consumer			2,747				1,793
Total consumer			3,040				2,166
Real estate:
Construction			2,761				3,411
Single family residential			12,722				12,139
Other commercial			20,368				12,385
Total real estate			35,851				27,935
Commercial:
Commercial			16,169				7,765
Agricultural			2,066				1,238
Total commercial			18,235				9,003
Total		$	57,126			$	39,104

 

 

 

An age analysis of past due loans, excluding loans acquired, segregated by class of loans, is as follows:

 

(In thousands)		Gross 30-89 Days Past Due				90 Days or More Past Due				Total Past Due				Current				Total Loans				90 Days Past Due & Accruing
June 30, 2017
Consumer:
Credit cards		$	568			$	565			$	1,133			$	175,820			$	176,953			$	271
Other consumer			3,301				1,779				5,080				361,056				366,136				10
Total consumer			3,869				2,344				6,213				536,876				543,089				281
Real estate:
Construction			950				1,748				2,698				455,198				457,896				--
Single family residential			5,429				5,756				11,185				1,003,227				1,014,412				--
Other commercial			3,385				9,542				12,927				2,076,780				2,089,707				--
Total real estate			9,764				17,046				26,810				3,535,205				3,562,015				--
Commercial:
Commercial			7,408				8,543				15,951				662,981				678,932				--
Agricultural			53				2,009				2,062				189,283				191,345				--
Total commercial			7,461				10,552				18,013				852,264				870,277				--
Other			--				--				--				25,191				25,191				--
Total		$	21,094			$	29,942			$	51,036			$	4,949,536			$	5,000,572			$	281
December 31, 2016
Consumer:
Credit cards		$	716			$	275			$	991			$	183,600			$	184,591			$	275
Other consumer			3,786				1,027				4,813				299,159				303,972				11
Total consumer			4,502				1,302				5,804				482,759				488,563				286
Real estate:
Construction			1,420				1,246				2,666				334,093				336,759				--
Single family residential			6,310				5,927				12,237				892,008				904,245				14
Other commercial			4,212				6,722				10,934				1,776,141				1,787,075				--
Total real estate			11,942				13,895				25,837				3,002,242				3,028,079				14
Commercial:
Commercial			2,040				5,296				7,336				632,189				639,525				--
Agricultural			121				1,215				1,336				149,042				150,378				--
Total commercial			2,161				6,511				8,672				781,231				789,903				--
Other			--				--				--				20,662				20,662				--
Total		$	18,605			$	21,708			$	40,313			$	4,286,894			$	4,327,207			$	300

 

Impaired Loans – A loan is considered impaired when it is probable that the Company will not receive all amounts due according to the contractual terms of the loans, including scheduled principal and interest payments.  This includes loans that are delinquent 90 days or more, nonaccrual loans and certain other loans identified by management.  Certain other loans identified by management consist of performing loans with specific allocations of the allowance for loan losses. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of the collateral if the loan is collateral dependent.  

 

Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans.  Impaired loans, or portions thereof, are charged-off when deemed uncollectible.

 

 

Impaired loans, net of government guarantees and excluding loans acquired, segregated by class of loans, are as follows:

 

(In thousands)		Unpaid Contractual Principal Balance				Recorded Investment With No Allowance				Recorded Investment With Allowance				Total Recorded Investment				Related Allowance				Average Investment in Impaired Loans				Interest Income Recognized				Average Investment in Impaired Loans				Interest Income Recognized
June 30, 2017																						Three Months Ended June 30, 2017								Six Months Ended June 30, 2017
Consumer:
Credit cards		$	293			$	293			$	--			$	293			$	--			$	261			$	6			$	298			$	11
Other consumer			2,824				2,747				--				2,747				--				2,581				17				2,321				31
Total consumer			3,117				3,040				--				3,040				--				2,842				23				2,619				42
Real estate:
Construction			3,309				1,755				1,006				2,761				156				2,748				21				2,969				39
Single family residential			13,423				12,004				718				12,722				46				12,837				90				12,686				167
Other commercial			22,562				7,324				13,044				20,368				1,686				22,402				138				19,670				258
Total real estate			39,294				21,083				14,768				35,851				1,888				37,987				249				35,325				464
Commercial:
Commercial			17,682				4,674				11,495				16,169				3,636				14,275				91				12,952				170
Agricultural			3,183				2,066				--				2,066				--				2,152				13				1,840				24
Total commercial			20,865				6,740				11,495				18,235				3,636				16,427				104				14,792				194
Total		$	63,276			$	30,863			$	26,263			$	57,126			$	5,524			$	57,256			$	376			$	52,736			$	700
December 31, 2016																							Three Months Ended June 30, 2016								Six Months Ended June 30, 2016
Consumer:
Credit cards		$	373			$	373			$	--			$	373			$	--			$	216			$	--			$	304			$	10
Other consumer			1,836				1,797				3				1,800				1				841				12				708				18
Total consumer			2,209				2,170				3				2,173				1				1,057				12				1,012				28
Real estate:
Construction			4,275				1,038				2,374				3,412				156				5,089				61				5,044				126
Single family residential			12,970				10,630				1,753				12,383				162				9,032				110				7,904				197
Other commercial			20,993				6,891				7,315				14,206				99				19,976				220				14,789				370
Total real estate			38,238				18,559				11,442				30,001				417				34,097				391				27,737				693
Commercial:
Commercial			11,848				2,734				7,573				10,307				262				2,539				31				2,355				59
Agricultural			2,226				1,215				--				1,215				--				1,084				15				810				20
Total commercial			14,074				3,949				7,573				11,522				262				3,623				46				3,165				79
Total		$	54,521			$	24,678			$	19,018			$	43,696			$	680			$	38,777			$	449			$	31,914			$	800

 

At June 30, 2017, and December 31, 2016, impaired loans, net of government guarantees and excluding loans acquired, totaled $57.1 million and $43.7 million, respectively.  Allocations of the allowance for loan losses relative to impaired loans were $5.5 million and $680,000 at June 30, 2017 and December 31, 2016, respectively. Approximately $376,000 and $700,000 of interest income was recognized on average impaired loans of $57.3 million and $52.7 million for the three and six months ended June 30, 2017.  Interest income recognized on impaired loans on a cash basis during the three and six months ended June 30, 2017 and 2016 was not material.

 

Included in certain impaired loan categories are troubled debt restructurings (“TDRs”).  When the Company restructures a loan to a borrower that is experiencing financial difficulty and grants a concession that it would not otherwise consider, a “troubled debt restructuring” results and the Company classifies the loan as a TDR.  The Company grants various types of concessions, primarily interest rate reduction and/or payment modifications or extensions, with an occasional forgiveness of principal.

 

 

Under ASC Topic 310-10-35 – Subsequent Measurement , a TDR is considered to be impaired, and an impairment analysis must be performed.  The Company assesses the exposure for each modification, either by collateral discounting or by calculation of the present value of future cash flows, and determines if a specific allocation to the allowance for loan losses is needed.

 

Once an obligation has been restructured because of such credit problems, it continues to be considered a TDR until paid in full; or, if an obligation yields a market interest rate and no longer has any concession regarding payment amount or amortization, then it is not considered a TDR at the beginning of the calendar year after the year in which the improvement takes place.  The Company returns TDRs to accrual status only if (1) all contractual amounts due can reasonably be expected to be repaid within a prudent period, and (2) repayment has been in accordance with the contract for a sustained period, typically at least six months.

 

The following table presents a summary of troubled debt restructurings, excluding loans acquired, segregated by class of loans.

 

		Accruing TDR Loans								Nonaccrual TDR Loans								Total TDR Loans
(Dollars in thousands)		Number				Balance				Number				Balance				Number				Balance
June 30, 2017
Real estate:
Construction			--			$	--				2			$	445				2			$	445
Single-family residential			1				43				19				1,212				20				1,255
Other commercial			6				6,624				4				8,089				10				14,713
Total real estate			7				6,667				25				9,746				32				16,413
Commercial:
Commercial			7				2,127				9				788				16				2,915
Total commercial			7				2,127				9				788				16				2,915
Total			14			$	8,794				34			$	10,534				48			$	19,328
December 31, 2016
Consumer:
Other consumer			--			$	--				1			$	3				1			$	3
Total consumer			--				--				1				3				1				3
Real estate:
Construction			--				--				1				18				1				18
Single-family residential			3				167				29				2,078				32				2,245
Other commercial			23				9,048				2				780				25				9,828
Total real estate			26				9,215				32				2,876				58				12,091
Commercial:
Commercial			15				1,783				5				297				20				2,080
Total commercial			15				1,783				5				297				20				2,080
Total			41			$	10,998				38			$	3,176				79			$	14,174

 

 

 

The following table presents loans that were restructured as TDRs during the three and six months ended June 30, 2017 and 2016, excluding loans acquired, segregated by class of loans.

 

														Modification Type
(Dollars in thousands)		Number of Loans				Balance Prior to TDR				Balance at June 30				Change in Maturity Date				Change in Rate				Financial Impact on Date of Restructure
Three Months Ended June 30, 2017
Commercial:
Commercial			4			$	41			$	39			$	--			$	39			$	--
Total commercial			4				41				39				--				39				--
Total			4			$	41			$	39			$	--			$	39			$	--
Three Months Ended June 30, 2016
Consumer:
Other consumer			1			$	3			$	3			$	3			$	--			$	--
Total consumer			1				3				3				3				--				--
Real Estate:
Single-family residential			7				618				615				61				554				--
Other commercial			1				348				364				--				364				--
Total real estate			8				966				979				61				918				--
Commercial:
Commercial			9				426				399				399				--				--
Total commercial			9				426				399				399				--				--
Total			18			$	1,395			$	1,381			$	463			$	918			$	--
Six Months Ended June 30, 2017
Real estate:
Construction			1			$	456			$	456			$	456			$	--			$	--
Other commercial			2				7,362				7,362				7,362				--				33
Total real estate			3				7,818				7,818				7,818				--				33
Commercial:
Commercial			9				811				799				760				39				--
Total commercial			9				811				799				760				39				--
Total			12			$	8,629			$	8,617			$	8,578			$	39			$	33
Six Months Ended June 30, 2016
Consumer:
Other consumer			1			$	3			$	3			$	3			$	--			$	--
Total consumer			1				3				3				3				--				--
Real estate:
Single-family residential			9				796				793				239				554				--
Other commercial			25				8,962				8,931				8,567				364				--
Total real estate			34				9,758				9,724				8,806				918				--
Commercial:
Commercial			11				600				572				572				--				--
Total commercial			11				600				572				572				--
Total			46			$	10,361			$	10,299			$	9,381			$	918			$	--

 

During the three months ended June 30, 2017, the Company modified 4 loans with a recorded investment of $41,000 prior to modification which were deemed troubled debt restructuring.  The restructured loans were modified by changing the interest rate.  Based on the fair value of the collateral, no specific reserve was determined necessary for these loans.  Also, there was no immediate financial impact from the restructuring of these loans, as it was not considered necessary to charge-off interest or principal on the date of restructure.

 

During the six months ended June 30, 2017, the Company modified 12 loans with a recorded investment of $8.6 million prior to modification which was deemed troubled debt restructuring. The restructured loans were modified by deferring amortized principal payments, changing the maturity date and requiring interest only payments for a period of 12 months. Based on the fair value of the collateral, a specific reserve of $33,000 was determined necessary for these loans. Also, there was no immediate financial impact from the restructuring of these loans, as it was not considered necessary to charge-off interest or principal on the date of restructure.

 

 

During the three months ended June 30, 2016, the Company modified 18 loans with a recorded investment of $1.4 million and during the six months ended June 30, 2016, the Company modified 46 loans with a total recorded investment of $10.4 million prior to modification which were deemed troubled debt restructuring.  The restructured loans were modified by changing various terms, including changing the maturity date, deferring amortized principal payments and requiring interest only payments for a period of 12 months.  Based on the fair value of the collateral, a specific reserve of $324,000 was determined necessary for these loans.  Also, there was no immediate financial impact from the restructuring of these loans, as it was not considered necessary to charge-off interest or principal on the date of restructure.

 

There was one commercial real estate loan for which a payment default occurred during the six months ended June 30, 2017, and that had been modified as a TDR within 12 months or less of the payment default, excluding loans acquired. There were no loans for which a payment default occurred during the six months ended June 30, 2016, and that had been modified as a TDR within 12 months or less of the payment default, excluding loans acquired.  We define a payment default as a payment received more than 90 days after its due date.

 

In addition to the TDRs that occurred during the period provided in the preceding tables, the Company had TDRs with pre-modification loan balances of $117,000 and $166,500 at June 30, 2017 and 2016, respectively, for which other real estate owned (“OREO”) was received in full or partial satisfaction of the loans. The majority of such TDRs were in commercial real estate and residential real estate. At June 30, 2017 and December 31, 2016, the Company had $1,321,000 and $1,714,000, respectively, of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process. At June 30, 2017 and December 31, 2016, the Company had $2,648,000 and $5,094,000, respectively, of OREO secured by residential real estate properties.

 

Credit Quality Indicators – As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk rating of commercial and real estate loans, (ii) the level of classified commercial and real estate loans, (iii) net charge-offs, (iv) non-performing loans (see details above) and (v) the general economic conditions in the States of Arkansas, Kansas, Missouri and Tennessee.

 

The Company utilizes a risk rating matrix to assign a risk rate to each of its commercial and real estate loans. Loans are rated on a scale of 1 to 8.  A description of the general characteristics of the 8 risk ratings is as follows:

 

·

Risk Rate 1 – Pass (Excellent) – This category includes loans which are virtually free of credit risk.  Borrowers in this category represent the highest credit quality and greatest financial strength.

 

·

Risk Rate 2 – Pass (Good) - Loans under this category possess a nominal risk of default.  This category includes borrowers with strong financial strength and superior financial ratios and trends.  These loans are generally fully secured by cash or equivalents (other than those rated "excellent”).

 

·

Risk Rate 3 – Pass (Acceptable – Average) - Loans in this category are considered to possess a normal level of risk.  Borrowers in this category have satisfactory financial strength and adequate cash flow coverage to service debt requirements.  If secured, the perfected collateral should be of acceptable quality and within established borrowing parameters.

 

·

Risk Rate 4 – Pass (Monitor) - Loans in the Watch (Monitor) category exhibit an overall acceptable level of risk, but that risk may be increased by certain conditions, which represent "red flags".  These "red flags" require a higher level of supervision or monitoring than the normal "Pass" rated credit.  The borrower may be experiencing these conditions for the first time, or it may be recovering from weakness, which at one time justified a harsher rating.  These conditions may include: weaknesses in financial trends; marginal cash flow; one-time negative operating results; non-compliance with policy or borrowing agreements; poor diversity in operations; lack of adequate monitoring information or lender supervision; questionable management ability/stability.

 

·

Risk Rate 5 – Special Mention - A loan in this category has potential weaknesses that deserve management's close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date.  Special Mention loans are not adversely classified (although they are "criticized") and do not expose an institution to sufficient risk to warrant adverse classification.  Borrowers may be experiencing adverse operating trends, or an ill-proportioned balance sheet.  Non-financial characteristics of a Special Mention rating may include management problems, pending litigation, a non-existent, or ineffective loan agreement or other material structural weakness, and/or other significant deviation from prudent lending practices.

 

 

·

Risk Rate 6 – Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt.  The loans are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.  This does not imply ultimate loss of the principal, but may involve burdensome administrative expenses and the accompanying cost to carry the loan.

 

·

Risk Rate 7 – Doubtful – A loan classified Doubtful has all the weaknesses inherent in a substandard loan except that the weaknesses make collection or liquidation in full (on the basis of currently existing facts, conditions, and values) highly questionable and improbable. Doubtful borrowers are usually in default, lack adequate liquidity, or capital, and lack the resources necessary to remain an operating entity.  The possibility of loss is extremely high, but because of specific pending events that may strengthen the asset, its classification as loss is deferred.  Pending factors include: proposed merger or acquisition; liquidation procedures; capital injection; perfection of liens on additional collateral; and refinancing plans.  Loans classified as Doubtful are placed on nonaccrual status.

 

·

Risk Rate 8 – Loss - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the loans has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless loan, even though partial recovery may be affected in the future.  Borrowers in the Loss category are often in bankruptcy, have formally suspended debt repayments, or have otherwise ceased normal business operations.  Loans should be classified as Loss and charged-off in the period in which they become uncollectible.

 

Loans acquired are evaluated using this internal grading system. Loans acquired are evaluated individually and include purchased credit impaired loans of $8.4 million and $17.8 million that are accounted for under ASC Topic 310-30 and are classified as substandard (Risk Rating 6) as of June 30, 2017 and December 31, 2016, respectively. Of the remaining loans acquired and accounted for under ASC Topic 310-20, $33.2 million and $47.8 million were classified (Risk Ratings 6, 7 and 8 – see classified loans discussion below) at June 30, 2017 and December 31, 2016, respectively.

 

Purchased credit impaired loans are loans that showed evidence of deterioration of credit quality during the loan term and for which it is probable, at acquisition, that the Company will be unable to collect all amounts contractually owed. Their fair value was initially based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the undiscounted cash flows expected at acquisition and the fair value at acquisition is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition are not recognized as a yield adjustment. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairment.

 

Classified loans for the Company include loans in Risk Ratings 6, 7 and 8.  Loans may be classified, but not considered impaired, due to one of the following reasons:  (1) The Company has established minimum dollar amount thresholds for loan impairment testing.  Loans rated 6 – 8 that fall under the threshold amount are not tested for impairment and therefore are not included in impaired loans.  (2) Of the loans that are above the threshold amount and tested for impairment, after testing, some are considered to not be impaired and are not included in impaired loans.  Total classified loans, excluding loans accounted for under ASC Topic 310-30, were $156.1 million and $166.0 million, as of June 30, 2017 and December 31, 2016, respectively.

 

 

The following table presents a summary of loans by credit risk rating as of June 30, 2017 and December 31, 2016, segregated by class of loans. Loans accounted for under ASC Topic 310-30 are all included in Risk Rate 1-4 in this table.

 

(In thousands)		Risk Rate 1-4				Risk Rate 5				Risk Rate 6				Risk Rate 7				Risk Rate 8				Total
June 30, 2017
Consumer:
Credit cards		$	176,388			$	--			$	565			$	--			$	--			$	176,953
Other consumer			363,073				--				3,063				--				--				366,136
Total consumer			539,461				--				3,628				--				--				543,089
Real estate:
Construction			449,699				1,739				6,442				16				--				457,896
Single family residential			986,793				3,288				24,179				152				--				1,014,412
Other commercial			2,031,129				6,611				51,967				--				--				2,089,707
Total real estate			3,467,621				11,638				82,588				168				--				3,562,015
Commercial:
Commercial			651,846				2,022				25,061				3				--				678,932
Agricultural			188,224				129				2,969				23				--				191,345
Total commercial			840,070				2,151				28,030				26				--				870,277
Other			25,191				--				--				--				--				25,191
Loans acquired			1,150,104				32,960				40,182				1,486				7				1,224,739
Total		$	6,022,447			$	46,749			$	154,428			$	1,680			$	7			$	6,225,311

 

(In thousands)		Risk Rate 1-4				Risk Rate 5				Risk Rate 6				Risk Rate 7				Risk Rate 8				Total
December 31, 2016
Consumer:
Credit cards		$	183,943			$	--			$	648			$	--			$	--			$	184,591
Other consumer			301,632				26				2,314				--				--				303,972
Total consumer			485,575				26				2,962				--				--				488,563
Real estate:
Construction			330,080				98				6,565				16				--				336,759
Single family residential			875,603				4,024				24,460				158				--				904,245
Other commercial			1,738,207				6,874				41,994				--				--				1,787,075
Total real estate			2,943,890				10,996				73,019				174				--				3,028,079
Commercial:
Commercial			616,805				558				22,162				--				--				639,525
Agricultural			148,218				104				2,033				--				23				150,378
Total commercial			765,023				662				24,195				--				23				789,903
Other			20,662				--				--				--				--				20,662
Loans acquired			1,217,886				22,181				64,075				1,541				--				1,305,683
Total		$	5,433,036			$	33,865			$	164,251			$	1,715			$	23			$	5,632,890

 

 

 

Allowance for Loan Losses

 

Allowance for Loan Losses – The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310-10, Receivables , and allowance allocations calculated in accordance with ASC Topic 450-20, Loss Contingencies . Accordingly, the methodology is based on the Company’s internal grading system, specific impairment analysis, qualitative and quantitative factors.

 

As mentioned above, allocations to the allowance for loan losses are categorized as either specific allocations or general allocations.

 

A loan is considered impaired when it is probable that the Company will not receive all amounts due according to the contractual terms of the loan, including scheduled principal and interest payments. For a collateral dependent loan, the Company’s evaluation process includes a valuation by appraisal or other collateral analysis. This valuation is compared to the remaining outstanding principal balance of the loan. If a loss is determined to be probable, the loss is included in the allowance for loan losses as a specific allocation. If the loan is not collateral dependent, the measurement of loss is based on the difference between the expected and contractual future cash flows of the loan.

 

The general allocation is calculated monthly based on management’s assessment of several factors such as (1) historical loss experience based on volumes and types, (2) volume and trends in delinquencies and nonaccruals, (3) lending policies and procedures including those for loan losses, collections and recoveries, (4) national, state and local economic trends and conditions, (5) external factors and pressure from competition, (6) the experience, ability and depth of lending management and staff, (7) seasoning of new products obtained and new markets entered through acquisition and (8) other factors and trends that will affect specific loans and categories of loans. The Company establishes general allocations for each major loan category. This category also includes allocations to loans which are collectively evaluated for loss such as credit cards, one-to-four family owner occupied residential real estate loans and other consumer loans.

 

 

 

The following table details activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2017.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

(In thousands)		Commercial				Real Estate				Credit Card				Other Consumer and Other				Total
Three Months Ended June 30, 2017
Balance, beginning of period (2)		$	8,173			$	22,253			$	3,729			$	3,710			$	37,865
Provision for loan losses (1)			249				4,974				649				436				6,308
Charge-offs			(349	)			(1,712	)			(901	)			(993	)			(3,955	)
Recoveries			32				216				277				636				1,161
Net recoveries (charge-offs)			(317	)			(1,496	)			(624	)			(357	)			(2,794	)
Balance, June 30, 2017 (2)		$	8,105			$	25,731			$	3,754			$	3,789			$	41,379
Six Months Ended June 30, 2017
Balance, beginning of period (2)		$	7,739			$	21,817			$	3,779			$	2,951			$	36,286
Provision for loan losses (1)			945				5,834				1,407				1,679				9,865
Charge-offs			(641	)			(2,368	)			(1,945	)			(2,167	)			(7,121	)
Recoveries			62				448				513				1,326				2,349
Net charge-offs			(579	)			(1,920	)			(1,432	)			(841	)			(4,772	)
Balance, June 30, 2017 (2)		$	8,105			$	25,731			$	3,754			$	3,789			$	41,379
Period-end amount allocated to:
Loans individually evaluated for impairment		$	3,636			$	1,888			$	--			$	--			$	5,524
Loans collectively evaluated for impairment			4,469				23,843				3,754				3,789				35,855
Balance, June 30, 2017 (2)		$	8,105			$	25,731			$	3,754			$	3,789			$	41,379

____________________________

(1)

Provision for loan losses of $714,000 and $1,464,000 attributable to loans acquired was excluded from this table for the three and six months ended June 30, 2017, respectively (total provision for loan losses for the three and six months ended June 30, 2017 was $7,023,000 and $11,330,000). There were $758,000 and $2.0 million in charge-offs for loans acquired during the three and six months ended June 30, 2017, respectively, resulting in an ending balance in the allowance related to loans acquired of $391,000.

(2)

Allowance for loan losses at June 30, 2017 includes $391,000 allowance for loans acquired (not shown in the table above). Allowance for loan losses at March 31, 2017 includes $435,000 allowance for loans acquired. Allowance for loan losses at December 31, 2016 includes $954,000 allowance for loans acquired. The total allowance for loan losses at June 30, 2017, March 31, 2017 and December 31, 2016 was $41,770,000, $38,300,000 and $37,240,000, respectively.

 

 

 

Activity in the allowance for loan losses for the three and six months ended June 30, 2016 was as follows:

 

(In thousands)		Commercial				Real Estate				Credit Card				Other Consumer and Other				Total
Three Months Ended June 30, 2016
Balance, beginning of period (4)		$	7,083			$	19,925			$	3,757			$	1,916			$	32,681
Provision for loan losses (3)			2,714				423				440				732				4,309
Charge-offs			(2,283	)			(824	)			(702	)			(489	)			(4,298	)
Recoveries			318				111				253				149				831
Net charge-offs			(1,965	)			(713	)			(449	)			(340	)			(3,467	)
Balance, June 30, 2016 (4)		$	7,832			$	19,635			$	3,748			$	2,308			$	33,523
Six Months Ended June 30, 2016
Balance, beginning of period (4)		$	5,985			$	19,522			$	3,893			$	1,951			$	31,351
Provision for loan losses (3)			4,281				943				921				987				7,132
Charge-offs			(2,759	)			(1,053	)			(1,561	)			(882	)			(6,255	)
Recoveries			325				223				495				252				1,295
Net charge-offs			(2,434	)			(830	)			(1,066	)			(630	)			(4,960	)
Balance, June 30, 2016 (4)		$	7,832			$	19,635			$	3,748			$	2,308			$	33,523
Period-end amount allocated to:
Loans individually evaluated for impairment		$	63			$	3,080			$	--			$	6			$	3,149
Loans collectively evaluated for impairment			7,769				16,555				3,748				2,302				30,374
Balance, June 30, 2016 (4)		$	7,832			$	19,635			$	3,748			$	2,308			$	33,523
Period-end amount allocated to:
Loans individually evaluated for impairment		$	262			$	417			$	--			$	1			$	680
Loans collectively evaluated for impairment			7,477				21,400				3,779				2,950				35,606
Balance, December 31, 2016 (5)		$	7,739			$	21,817			$	3,779			$	2,951			$	36,286

____________________________

(3)

Provision for loan losses of $307,000 attributable to loans acquired was excluded from this table for the three and six months ended June 30, 2016 (total provision for loan losses for the three and six months ended June 30, 2016 was $4,616,000 and $7,439,000). The $307,000 was subsequently charged-off, resulting in no change to the ending balance in the allowance related to loans acquired.

(4)

Allowance for loan losses at June 30, 2016, March 31, 2016 and December 31, 2015 includes $954,000 allowance for loans acquired. The total allowance for loan losses at June 30, 2016, March 31, 2016 and December 31, 2015 was $34,477,000, $33,635,000 and $32,305,000, respectively.

(5)

Allowance for loan losses at December 31, 2016 includes $954,000 allowance for loans acquired (not shown in the table above). The total allowance for loan losses December 31, 2016 was $37,240,000.

 

 

 

The Company’s recorded investment in loans, excluding loans acquired, related to each balance in the allowance for loan losses by portfolio segment on the basis of the Company’s impairment methodology was as follows:

 

(In thousands)		Commercial				Real Estate				Credit Card				Other Consumer and Other				Total
June 30, 2017
Loans individually evaluated for impairment		$	18,235			$	35,851			$	293			$	2,747			$	57,126
Loans collectively evaluated for impairment			852,042				3,526,164				176,660				388,580				4,943,446
Balance, end of period		$	870,277			$	3,562,015			$	176,953			$	391,327			$	5,000,572
December 31, 2016
Loans individually evaluated for impairment		$	11,522			$	30,001			$	373			$	1,800			$	43,696
Loans collectively evaluated for impairment			778,381				2,998,078				184,218				322,834				4,283,511
Balance, end of period		$	789,903			$	3,028,079			$	184,591			$	324,634			$	4,327,207